For DB plans, the most problematic feature of Dodd-Frank is the provision that they are “special,” and swap dealers trading with them must conform to a higher standard of conduct. This issue has, if anything, become more problematic with the proposal in December, by the Commodity Futures Trading Commission (CFTC), of rules under this provision that, it can be argued, go even further than the statute warrants.
Under the CFTC proposal, a swap dealer must, at a minimum, make sure that a plan has an adviser with “sufficient knowledge to evaluate the transaction and risks.” If the dealer has recommended the transaction to the plan (and recommendation here is merely suggesting that the plan might want to consider the transaction), then the dealer must also act in the “best interests” of the plan (as opposed to the best interests of their own firm).
This provision was put in Dodd-Frank by former Senator Blanche Lincoln in her fight to drive the predators from the temple of finance. (That seems a little ironic: Aren’t the money-changers supposed to be in the temple of finance; it’s their temple, right?) In describing this legislation, she said: “As Chairman of the Agriculture Committee…I became acutely aware that our pension plans, governmental investors, and charitable endowments were falling victim to swap dealers marketing swaps…that they knew or should have known to be inappropriate or unsuitable for their clients. Jefferson County, AL, is probably the most infamous example, but there are many others in Pennsylvania and across the country.” (I might also ask here, What do interest rate swaps have to do with agriculture?)
According to Business Week, Jefferson County (which includes Birmingham) entered into an interest rate swap in 2002 and 2003 that “nearly bankrupted the county during the credit crisis.” It appears that this deal had as much to do with municipal corruption as bad judgment—one Jefferson County official was convicted of bribery in connection with it.
But ex-Senator Lincoln’s bill didn’t just cover counties in Alabama and Pennsylvania (apparently, the vortex of these problems); it also makes “special” huge pension plans at companies like IBM and Verizon and Intel. So, the government thinks we’re all special.
But—as some companies (who fought this legislation) know and many more are going to find out—in the real and non-simple world, being treated as “special” can wind up being a burden. People don’t want to deal with you, at least not as much as somebody they don’t have to treat as special.
Critically, in our business, and in real life, financial institutions are going to spend less time developing derivatives products for pension plans, because the cost of marketing to those plans has gone up—because they are special. And—and this is so obvious that the CFTC even acknowledged that it was a problem—in the best of worlds, swap dealers are going to have a limited list of companies that they will accept as counterparty advisers. It seems to me that this will be a particular problem for large companies running in-house investment operations that use derivatives. What swap dealer—at the risk of violating the new business conduct standards—is going to accept an in-house group that only works on one company’s investments as having “sufficient knowledge to evaluate the transaction and risks”?
These sorts of laws—that extend the government’s benign and protective hand to the benighted—have been around for millennia. In the 19th century, for instance, there were laws preventing sailors, drunks, and women from entering into contracts. I thought that, in the last century or so, one of the things we all figured out was that these sorts of laws are implicitly condescending and explicitly disabling. In effect, they treat the persons they are trying to “protect” as less than fully functioning, adult persons, who cannot take care of themselves.
Indeed, the categories of “special entities” under Dodd-Frank are slightly arbitrary. One can easily imagine a sophisticated pension plan with $25 billion in assets taking advantage of a less-sophisticated swap dealer. For that matter, there are many swap-market participants that aren’t plans or municipalities but are nevertheless lambs waiting to be slaughtered. Why not protect them?
In that vein, I would like to propose an alternative rule that would, in any situation, “be fair” and protect the “less powerful.” In any given swap transaction, whichever counterparty has the most Bloomberg terminals will be a “fiduciary,” and the other person will be “special.”
There you go—problem solved.
Michael Barry is President of the Plan Advisory Services Group, a consulting group that helps financial services corporations with the regulatory issues facing their plan sponsor clients. He has had 30 years’ experience in the benefits field, in law and consulting firms.